Absolute beginners can earn big returns

INVESTORS anxious to avoid the pain of a double stock market dip are flocking to Absolute Return Funds, which were the third most popular buy among investors last month, accounting for 7 per cent of net sales, according to Cofunds, the financial planning network.

A relative newcomer to the world of investment, they sound simple, though are anything but. They have been available to institutional investors, such as pension funds, for more than a decade. But the first fund was only made available to ordinary investors about three years ago, with the launch of UK Absolute Alpha fund.

Since then the sector has grown to 50 funds with 14 billion under management. Standard Life's Investment Global Absolute Return Strategy is currently the biggest seller.

Absolute Return Funds aim to do just that. Ensure that you make some sort of positive return on your investment, and don't lose money. Recent guidance from the Investment Management Association spelt out that the fund must make a positive return over a rolling 12-month period, to be included in the category.

It is important to stress that this is the aim of the funds. Not all achieve, certainly not all the time. There is no guarantee that you will not lose money if the market crashes unexpectedly, as you would with any other fund.

However, Black Rock points out that when the market fell by 30 per cent in 2009, its UK Alpha fund achieved a positive return of 1.5 per cent.

Essentially, these funds are designed to give a smooth, steady return over the long term, without the thrills and spills of stock market highs and lows. They are designed for investors whose nerves, or indeed hearts, cannot stand sudden market jolts

As such, they are coming to occupy the space traditionally held by with-profit funds, which are now largely discredited. In the long term, the return should be similar to that of the various indices. But the value will not soar as high in the good times, nor crash as low. That, anyway, is the intention.

Investor confidence suffered badly during the credit crunch market crash, but with cash on deposit offering such poor returns, savings are hungry for a low-risk option offering a real return.

Co-funds manager Michelle Woodburn said: "Since the start of the year we have seen a gradual increase in investor activity. We haven't seen the huge peaks and troughs normally associated with a bubble, which indicates that it is a trend which is here to stay."

Absolute return funds can promise to make money whether the market is rising or falling, because unlike traditional funds, they can invest in a very wide range of different instruments, including cash and derivatives. The difficulty for investors is that each of these funds is different, and their structures and strategies can be complex. Choosing one without the help of a financial adviser can be problematic.

Woodburn added: "Financial advisers like them, because in the current climate they want something they can offer clients that won't go down."

But not all advisers are fans. Financial adviser Patrick Connolly of AWD Chase de Vere said he was concerned at the confusing way these funds are marketed. For greater clarity, he believes the name "absolute return" should be scrapped, and funds described precisely by what they do.

He said: "Absolute Return gives the perception that the return will always go up, but that is not the case. Another problem is that there are lots of different funds doing entirely different things in the same sector. Investors are buying into them without understanding how they work."

Nevertheless, he believes there are some good funds out there, which have merit and are doing a good job.

Connolly adds: "We like the Black Rock UK Absolute Alpha, Newton Real Return Fund, and Standard Life's Global Absolute Return Strategy Fund."

At Black Rock, which has two absolute return funds, the UK and European Alpha, managers employ four essential strategies.

They buy shares which they expect to go up in the normal way, but they also short stock they expect to fall.

With shorting, a fund manager borrows shares and sells then them, because he thinks they will go down. He then buys it back at a cheaper price and returns it to the owner, making a profit on the difference.

Its third strategy takes this one step further in a matching exercise known as pair trading.

Essentially, the manager buys two stocks in the same sector. He buys stock A in the expectation that it will go up. The other, stock B, he takes a short position in, on the belief that the price will fall. It doesn't actually matter whether the share prices rise or fall, provided stock A outperforms stock B. Here the profit is the difference between the two.

The fourth strategy is provided by the scope to hold 100 per cent cash. If the manager sees storm clouds gathering on the horizon, he can liquidate the portfolio, and ride it out in cash.

Standard Life Global Absolute Return strategy fund, run by Euan Munro and his team, aims to deliver a performance of 5 per cent above what can be earned in cash on a three-year rolling basis. So far it is just shy of the 5 per cent return before charges.

It differs from Black Rock in that rather than concentrating on a particular market, such as the UK or Europe, it hunts across all markets and all asset classes for investment opportunities.

It too uses a pairing strategy, but rather than simply pairing stocks, it will pair entire markets or asset classes by, for example, matching equities with high-yielding bonds.

It also invests in a wide range of assets, taking bets on currencies, interest rates and inflation, as well as the normal property, stocks and shares.

The Newton Real Return Fund operates differently again from the other two. It has a very diversified multi-asset approach, but doesn't exploit derivatives and other hedge-fund-like strategies in the way the other two do.

Steve Wilson, an adviser at Alan Steel Asset Management (ASAM), in Linlithgow is concerned about the use of derivatives in these funds.

He said: "Cautious investors shouldn't be investing in derivatives, which caused such problems during the credit crunch. Furthermore, it isn't true to say that these funds can offer a protection against market falls. Some funds were seriously hit by the crash, and some had invested in toxic mortgages."

Another point to watch closely is the charges, not least because performance is usually quoted before they have been taken into account.

In general, absolute return funds can be more expensive to run and some operate a performance fee. But this only normally kicks in if performance exceeds expectation.

But performance fees are not universal. The Standard Life fund does not have one, charging 1.5 per cent annually, with an initial 4 per cent charge. However, it is possible to reduce the upfront fee by dealing through a discount broker.